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Sunday, August 29, 2010

More-Than-Ever Worked Up About Nothing

I missed some of this stuff, as I try not to read DeLong's blog, for fear of depreciating my human capital. Here's a Krugman post, and a DeLong post relating to this. Having a rational discussion with these guys is something like having afternoon tea with a couple of hyperactive ferrets.

Here's what I said in response to a commenter:

This is a long-run proposition. I know it's confusing. Tighter monetary policy, in the short run, raises nominal interest rates. Ultimately, the lower monetary growth as the result of tightening leads to lower inflation and lower nominal interest rates over a longer horizon. Look at what happened after the Volcker tightening. Nominal interest rates went up, then they came back down again as the inflation rate fell. In the short run, there is a "liquidity effect" whereby tight monetary policy tends to increase the nominal interest rate. In the long run, what dominates is the "Fisher effect" whereby an inflation premium gets built into the nominal interest rate.

That's pretty much what Krugman and DeLong seem to be trying to say. What's all the heat about?

8 comments:

It's really simple, you haven't yet answered the question. In fact, you seem to be hiding from it. We understand you have problems with DeLong and Krugman (and, apparently, with me too given all the names you've managed to call me in comments and in posts), but will you ever actually address the questions that have been raised? In Brad's post or, better yet, here?:

The best interpretation I have seen was made by Adam P in a comment at Rowe's blog:"the very worst part of what Kocherlakota said is that he was advocating for a policy and that policy was to tighten monetary policy *TODAY*.If the Fed stands ready to raise rates before inflation has increased (based on other indications of a normalization) then that is a change in the reaction function that constitutes a tightening. (Look at it this way, in Sumner's phrasing it is a statement that the Fed stands ready to reduce the money supply even earler than we though, the monetary injection has gotten *less permanent*)."

He says: "Eventually, the real economy will improve sufficiently that the real return to safe short-term investments will normalize at its more typical positive level. The FOMC has to be ready to increase its target rate soon thereafter."

That is certainly NOT arguing for tightening today. It's off in the indefinite future.

I think you and Adam are using the phrase "tightening today" in a different sense. Kocherlakota is certainly not suggesting that the Fed should raise interest rates soon. I don't think anyone interprets his statements that way. But according to Adam, he is suggesting the Fed should raise interest rates sooner (relative to hypothetical future events) than the consensus believed it would. Since the market's response depends in part on expected future monetary policy, Adam considers that "announcement" to be a tightening, even though it has no immediate effect on the Fed's actions.

I'm not sure I agree with Adam on that point, though. It's not as if people thought Kocherlakota was a dove before that speech came out. Both sides are going to be making arguments for their case, so even though the specific content of this speech may have come as a surprise, it's not a big development in the broader progress of Fedspeak (unless it convinces a lot of people, but it doesn't seem to be doing so).